Mary Meeker on China's Online Future

September 22, 2005

Morgan Stanley's Mary Meeker made a name for herself in the late 1990s as one of the most bullish analysts of the Internet. With investors' exuberant response in August to the Nasdaq IPO of Chinese search company Baidu (BIDU), the Chinese Internet market is now attracting a lot of attention from analysts -- including Meeker, who recently was in Hong Kong to promote a new report that she and colleague Richard Ji prepared on the country and its Internet companies. While there, she spoke with Bruce Einhorn, BusinessWeek's Asia economics editor. Following are edited excerpts of their conversation:

The exuberant reaction to Baidu's Nasdaq IPO prompted a lot of people to say China is looking very bubbly. Is there a China Internet bubble?

Baidu was more of an exception than the rule. It was dubbed by many as the Google (GOOG) of China. That's a big idea and that helped people get excited about it. There was a supply and demand imbalance. I'm hopeful that we don't see that kind of speculation, and I don't think we will.

Why so much excitement about China's Internet?

It's the combination of one of the biggest markets in the world with the biggest evolution agents, if you will. They have kind of come together. We have defined it as an emerging market meeting an emerging market.

So from an investor standpoint, along with a lot of opportunity and interest, there comes a lot of risk. It's a little bit of either a double benefit or a double whammy. China is the No. 2 market in the world based on the number of Internet users. It will probably be No. 1 in the next two to five years. There are more Internet users under the age of 30 in China than any market in the world, by our estimates.

What do all those young people [about 70 million] mean for the development of the Chinese Net?

Oftentimes, the hotbeds of innovation in technology occur where you have the largest number of young users and the largest number of young engineers. So we actually think that while there hasn't been a tremendous amount of global innovation in the China Internet market -- most of the China Internet companies have adopted models that were developed in other markets first [such as] portal, online advertising, search, and, in effect, imported them to the Chinese market -- we think there's going to be a fair amount of innovation coming out of this market in the next three to five years.

Such as?

I can't tell you exactly what it's going to be, but when you throw the combination of the number of users with interest in the technology, [together] with coolness and smart engineers, stuff usually comes out of it.

If you look at the history of technology in the U.S., whether it was MIT and what happened in Boston with the minicomputer, or IBM (IBM) and the mainframe, or Silicon Valley, that's how it all comes together.

Any companies that stand out as innovators already?

We're certainly seeing some leadership in China. If we look at instant messaging, the ability to enhance instant-messaging services and generate revenue from them, [Shenzhen-based] Tencent is probably the leader in the world.

How does the Internet figure in the lives of Chinese compared to people in the U.S.?

I think if you were from another planet and dropped in on China and the U.S. 10 years ago, and [then] looked at the impact of the Internet today in China and the U.S., you might find that the relative impact has been greater in the China market, a) because there was less information flow [10 years ago], and b) there was less entertainment. The way especially the younger generation [in China] is using the Internet is probably more pervasive in their lives than potentially it is in the U.S.

Looking ahead a few years, what do you see changing?

If you asked [venture capitalists] five years ago what the No. 1 criticism was of China technology companies, they would [have said] lack of innovation and underdeveloped management teams. If you asked VCs a year ago, the same issues would come to the top. Five years from now, those two issues may be pushed aside.

Why?

Based on the quality of the teams we see developing. That will be a function of the way new technologies bubble up. The adage in Silicon Valley is you always have to be worried about the two kids in the garage who are going to destroy your business or the two kids in the dorm room who are using the new product to communicate with their buddies.

What we have never seen in my lifetime in China [is] that type of innovation bubbling up in the universities. [But that seems to be happening now.] Not only the usability of mobile phones and the Internet, but also with encouragement and focus. We can't tell you what exactly is going to come out of that because we don't know. But you put that ecosystem together, and stuff just starts to come out of it. That's what we have seen in the past.

A lot of people in the U.S. these days worry that those two dangerous kids in the dorm room are in Shanghai.

I tend to have a kind of a capitalistic view on all this stuff, and that is that the best ideas should win. There are a lot of reasons innovation has come out of the U.S. as it relates to the Internet.

Will it be lower five years from now? Yes, we think so. Will most of the innovation still be coming out of the U.S.? Yes. Will there be innovations that come out of China and Asia in general and Europe that begin to get applied in the U.S. market? Yes. But those will be things that consumers want, so it will make the market better.

Yahoo! (YHOO) made a big move into China last month with its $1 billion acquisition of Alibaba, the Chinese auction and B2B company. Was that a good deal?

They looked at China and said, "We've done O.K., but we weren't a market leader in China, and we want to be market leaders in the markets we're in. We could stay on our current path, which is unacceptable. We could do nothing, which is unacceptable. Or we could do something to try to have a stake in the game."

They looked at their available options. They probably would have liked to acquire some of the content companies, but can't because of regulatory restrictions. They said, "We know Softbank [an investor in Alibaba]. We know Masa-san [Softbank's Masayoshi Son]. And, as a derivative of that, we know Alibaba and Jack Ma [Alibaba founder], and we think Jack Ma is a good manager." I certainly think it's risky. But it didn't cost them that much.

The deal was worth a billion dollars. Did Yahoo pay too much?

The valuation is high. I think they did their numbers on the business, and that's the valuation they came up with. I think that it's high. Does this cause us to raise our earnings estimates on the company? No. Does this cause us to decrease our earnings estimates on the company? Maybe it will be a little dilutive. The reality is that it makes me feel neutral.

I say that because I applaud eBay's (EBAY) [purchase of] Skype. I can see more tangible benefits from that in the next two years than Yahoo Alibaba. Am I happy that Yahoo now has a stake in China? Yes. Am I happy about the valuation that they placed on the asset? No. Do I think it's a reasonable bet on the market? Yeah. Is it hard to argue with Jack Ma's success over the years? Yes. Does he have enough autonomy to do what he wants to do? Yes. So we'll see how it plays out.

Yahoo has taken a lot of criticism lately because of its role cooperating with a police investigation that landed a Chinese journalist in jail (see BW Online, 9/21/05, "A Cooler Look at Yahoo in China"). What do you think about the criticism that Yahoo and other U.S. companies such as Microsoft (MSFT) have received for the role they play in Beijing's attempts to control the Internet?

As a practical matter, the government of China does regulate and govern China. I think that there are certainly instances where they ask companies and people to do things that they don't do, that [the companies] are typically not asked in other markets. In each one of those situations, the company has to do an analysis of whether they want to comply or not comply, and benefit from the benefits or suffer the consequences.

Each has to be looked at on a case-by-case basis. I think it's an issue in the U.S. because it's different. People don't understand -- there are certainly people who feel that you should be able to do the same thing in China as in the U.S. There are people in China who feel differently. There are a lot of different competitive issues in the marketplace. I think that it's one of the reasons that most non-Chinese companies haven't been that successful in the Chinese market.

Which American companies do you think have the best shot of breaking that pattern in China?

We think the companies that have the biggest opportunity to be successful over time -- and when I say over time I mean 3 or 5 or 10 years -- are Google and eBay.

Google's mission is to organize the world's information and make it universally accessible and useful, and there are conflicts with that mission in China. Part of eBay's mission is to make inefficient markets efficient. Fifteen percent of eBay's trade is cross-border. One of the benefits that eBay brings to China is allowing Chinese people to access goods and services around the world, and vice versa.

What does Google have to offer China, though? Can't Baidu, Google's main Chinese rival, fulfill the same mission for Chinese Internet searchers? And can't Taobao, the consumer site run by Alibaba, take the place of eBay easily?

Today, search in China is China-centric. Most commerce in China is China-centric. The fact that Google is endeavoring to organize all the world's information and eBay is endeavoring to sell goods and services or allow them to trade around the world...will ultimately get tapped into the China market. But that will take a fair amount of time. Right now, I don't think that the Chinese people care about that as [much as] they will in 3 to 5 years.

Yahoo has its servers in China, which subjected it to the sort of laws that led to the recent controversy. Google doesn't yet. In the long term, is it possible for companies to just say, "I won't have my servers in China"?

I think there will be fits and starts. If they can't run their servers in China, they can't do their business in China. The user experience for a lot of Chinese sites is better than the user experience for a lot of the non-Chinese sites because they're faster. And speed matters. Speed and usability matter a lot.

How do you see Google growing in China?

There will be a lot of back and forth between the government and Google for years. As they cross each fork in the road, they will make the decisions that they make. The tricky thing is, information is only going to become more accessible. For China to endeavor to stop that trend is pretty hard. Will there be times that they do? Sure. But I think that you're fighting a tough battle.

One of the things that we think Google is working on is real-time language translation on the fly. That implies the ability to search for things in The New York Times or any newspaper and have it automatically translated into Chinese. It's the fight of efficiency vs. constraint -- and efficiency usually wins. But in China, it will undoubtedly take more time than in other markets because of government concerns.

What does eBay have to offer China?

It's an interesting bit of math here. If you look at eBay's take rate -- the portion that they keep, the net revenue -- it's about 10% to 11% globally. They keep that much. That's actually pretty small, they're keeping a relatively small cut of the transaction. And 90% of the value ends up in the hands of the seller.

So they're enabling entrepreneurship and enabling economic growth, unlike a lot of multinationals that go to markets and take a lot back with them. Over time, [what eBay does] benefits China. If sellers can sell products and they can sell them around the world and keep 90%, that's actually pretty good for entrepreneurship.

Don't eBay's rivals do that too?

That's fair. That may well be the way that it works out. But the difference for eBay is that eBay has more searchers on a global basis -- more searchers, more buyers, more sellers. The question is, five years from now, do China consumers who use Taobao just want China stuff, or do they want global stuff?

It's conceivable that these two companies could be in a pretty active battle for a long time. And it's not just about being able to sell to the rest of the world. It's about being able to find stuff and bring it in. If the China consumer can buy the product that they can't get in China or buy it more cheaply in Sweden -- I'm not sure what that product would be -- that's good for Chinese consumers.

When trade opens up, that's usually good for the lowest-cost producer and the consumer. And China is certainly a low-cost producer. The reality of eBay is that eBay has the potential over time to open the market to more China goods.

Do you think the Internet has lived up to its billing as something that will transform societies like China that have governments hostile to the free flow of information?

Is information in China as widely available as in the U.S.? No. Is information more widely available in China today that it was five years ago? Absolutely. What's the reason for that? The Internet.

The Internet has definitely been an empowerment tool and an educational tool. It's moving at a slower pace [in China] than the U.S. -- but it's still moving. And it's still moving in the right direction. I believe it's a matter of time.